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(Business 2.0) -
For most of its existence, eBay has enjoyed a virtual monopoly, if not an "Eliot Spitzer wants to talk" sort of monopoly. It now commands more than 90 percent of the online auction market, and from 1999 to 2004 it posted at least 40 percent annual profit growth every year, even as brawny competitors like Amazon and Yahoo were taking runs at its core business.

Yet, for all its phenomenal success, in 2006 eBay will face the toughest challenges of its 10-year history. The armies massing on its borders hail from Google and Microsoft, but rather than aim for eBay's auction business, the two behemoths want to use their strength in search and advertising to build dominance in online classifieds--the format that many analysts think will define the future of e-commerce. "eBay auctions are still too hard for many consumers to navigate," says Safa Rashtchy, senior analyst covering e-commerce and search at Piper Jaffray. "Overall, people prefer to buy locally, but there hasn't been an efficient way for them to find each other."

Fans of the populist website Craigslist, of which eBay owns a 25 percent stake, might disagree. But Craigslist doesn't have an online payment system or an industrial-strength shopping search engine that could help it grow into a major global player. Not to mention that founder Craig Newmark and CEO Jim Buckmaster seem in no hurry to expand on that scale. Two of the most formidable companies on the planet, however, are in more of a rush. Google and Microsoft certainly have the resources: Some say the invasion into eBay's turf began when Louis Monier, former director of advanced technology at eBay and the wizard behind its search innovations, was poached by Google last summer. The challengers also have a motive: The burgeoning online classifieds business is growing at a far faster clip than auctions.

Microsoft is expected to launch its listings service, code-named Fremont, toward the middle of this year (as part of Windows Live). Users will be able to post classifieds for free, limit access by buddy lists, and focus listings geographically; a tie-in to MSN's Virtual Earth mapping service will help buyers and sellers find each other easily. Google's foray, called Google Base, went live in mid-November. While still rudimentary, the beta version is a powerful foundation on which Google could build any number of products that compete with eBay. A massive, searchable database, the site allows users to post everything from recipes and concert dates to used cars and job listings, and local merchants can upload inventory data so buyers can see what's on the shelves in the bricks-and-mortar stores in their neighborhoods. With eBay acquiring nearly half of its new buyers and sellers in the United States through paid listings, mostly on Google and Yahoo, it could lose buyers if Google puts its own search results first.

"People could bypass eBay altogether," says Scot Wingo, CEO of ChannelAdvisor, which helps big eBay sellers like Best Buy maximize online sales. One of Wingo's clients, online shoe retailer Grapevinehill, recently started listing its inventory on Google Base, in addition to eBay. Owner Mark Fitzgerald says he made the move in order to reach Google's broader audience, and that the new listings are already driving traffic to his store: "We definitely see some momentum building," he says.

eBay isn't blind to this shift in e-commerce. Its recent acquisitions and launches--comparison site Shopping.com and international classifieds site Kijiji--lend themselves to the listings business. But for now, eBay CEO Meg Whitman seems to be taking a wait-and-see approach, noting that Google hasn't enjoyed phenomenal success outside of search. "We'll be interested to see fundamentally how much traction Google Base gets relative to Gmail, relative to Google Talk," she told analysts at a Dec. 1 conference in Scottsdale, Ariz. And eBay's strongest defense could turn out to be its fraud and payment staff--more than 1,000 employees--which Google and Microsoft have yet to match. "It's a huge advantage," says analyst David Edwards of American Technology Research. "People overlook how complicated eBay's business is."

Make no mistake, eBay is still on top of the Internet pure-plays. But for the first time in its history, there may be friction in its frictionless business model.